Questor share tip: Facebook valuation is too rich

Waiting for Friday’s Facebook debut there was definitely a feeling of déjà vu.

Reminiscent of the dot-com boom 12 years ago, there were claims that the shares would rise 40pc, 50pc or even double on its first day of dealings. This did not come to pass. The shares rose just 0.6pc.

The IPO was certainly popular, with more than 82m shares changing hands in the first 30 seconds of trading. Within half an hour the stock had leapt to $45 from its issue price of $38.

Mark Zuckerberg clearly made a savvy move turning down bids for the company in 2005 and 2006 worth up to $1.5bn.

The value of something is what someone else is willing to pay you for it, nothing more, nothing less. Investors were willing to pay this much, so it must be worth its valuation today. The question is, will it be worth that tomorrow?

In 2011, fully-diluted earnings per share (EPS) came in at 46c. If the company grows earnings by 50pc in the next two years, EPS will hit 103.5c, with a December 2013 multiple of almost 40.

The valuation is expensive – even if profits jump by half.

However, EPS jumped by 240pc in 2010, before slowing to 64pc in 2011.

Strong growth is needed in revenue and profits for many years to come in order to justify the valuation.

Revenues grew 154pc in 2010 and 88pc in 2011, so top line growth is already slowing. With 845m users compared with 6.8bn people on the planet, growth of 39pc a year in the number of people using the site, as seen in 2011, cannot carry on for long.

Mobile is a big concern. The IPO documents noted that Facebook does “not currently directly generate meaningful revenue” from its mobile app. With users migrating to mobile, this is a significant threat.

Investor excitement was palpable on Friday, with US stockbrokers reporting unprecedented demand from private investors. This brings to mind Warren Buffet’s adage: “Be fearful when others are greedy and greedy when others are fearful.” Why would you buy a company at 40 times potential earnings in 2013, when shares in quality names such as Apple are trading on a 2013 multiple of less than 10?

Apple has a proven track record of shareholder returns. If you admire Mr Zuckerberg don’t buy shares in Facebook. You’d get better long-term value buying a hooded top.